For years now, we have heard the savvy crowd chant the mantra, “Buy only term life insurance.” To which I would answer, “Maybe so, but maybe not.” Should you buy only bonds? Equities? Preferred stock? REIT’s? Commodities? To which you would answer, “Maybe so, but maybe not.”

We are experiencing a changing paradigm, a time when our life spans are increasing, a time when our “retirement years” may come close to equaling our career working years, a time when retirees are starting new businesses at an ever-increasing rate; some because they seek new challenges, and some because they need extra dollars to maintain their lifestyles.

Have you heard this chestnut? “Buy only term insurance, because as you age your children will grow up, your mortgage will be paid off, and your obligations will shrink. Take the term insurance ‘savings’ and invest them with your other investment dollars, and you will be swimming in cash by the time you’re ready to retire. By then you will have the cash to take care of your few remaining obligations, pay for your funeral, and stake your spouse to a comfortable future income.” Wrong! What happens when your term insurance period runs out? Will you still need the insurance? Will you be able to afford it at age 60 or 70? Will you still be able to qualify for it later on?

Somewhere along the way we forgot the meaning and purpose of life insurance. It isn’t an investment. It’s intended to be a hedge, a device to reduce a risk, a means to mitigate the loss of an income stream to a family, or offset the loss of a key person to a business. Inherent in any investment portfolio is the element of risk, whereas ownership of life insurance should be relatively risk-free.

Much has been made of the difference in premium amounts needed to pay for term vs. “whole life” insurance. That is comparing apples to oranges; both good food, but the similarities stop there. Actuaries, the math gurus of the insurance industry, rely on statistical data going back over a century coupled with long range investment data and other cost considerations, to set the purchase price for one year’s worth of term life insurance on an individual at a given age. As each year passes, that individual moves statistically closer to “buying the farm,” as they say. So each year the price goes up.

To level the premium amounts, the actuaries just add the one-year term premiums together for the number of years’ coverage required and then capitalize the total at a given rate of interest (does this sound familiar to you bankers and mortgage lenders?). For a 10 year term life insurance policy, add each year’s single premium for the 10 year period, capitalize the total, and presto, you have a 10 year level term life policy (this is very much the shorthand method, so don’t try this at home).

Okay, now follow this closely. A one-year term insurance premium will be pennies per thousand dollars worth of life insurance at very early ages, a few dollars at later ages, and lots of dollars at much older ages, because the pool of insureds is shrinking while the number of claims is growing. If you are 35 years old and want to insure yourself until at least age 95 (you must be at least 90 in order to bowl in my mother-in-law’s league), simply add together the single year term premiums for all years from your age 35 to 95, then capitalize the total at a given interest rate. The result will be your level premium for all years from age 35 to 95. But wait! Your level premium during the beginning years of your policy is higher than those of a shorter period term policy. What’s going on?

If you follow that “higher” premium out to your policy’s intermediate and later years, you will discover that it becomes lower, and later, much lower than the term premiums in those out years. So how does your policy stay afloat? Well, during those “higher than the one year term premium” years, the “overpayment” is placed into the insurance company’s general investment account together with other dollars attributed to your policy. There it earns interest sufficient to cover the short fall in those later years when your level premiums are less than the one-year term premiums. The result is your policy’s “reserve” account, and you will recognize it as your policy’s “cash value,” the amount of which is a function of the reserve. And that is why you must pay interest on dollars borrowed from your policy’s cash value...because you have extracted some of your reserve dollars from the insurance company’s investment account.

So if your need for life insurance is great but your ability to pay for it is not, you must opt for term insurance for a time. If your life insurance need is for a specific purpose that will go away after a set period of time, term insurance may also be in order. If you anticipate a long-term need for life insurance, consider “whole life” insurance in one of its various forms. Or you may consider a blended policy, made up of part term and part whole life.

And so it goes. You can set up life insurance for one year, five years, 55 years, to age 100 and ever after. The math mechanics are always the same. In the end, it’s all term insurance.

Kenneth L. Smith, CLU, FLMI,
owns Insurance Planning Services.
He can be reached at 904-285-5255
or by Email at ksmith6288@aol.com.